The Changing Face of Economic Federalism

With the Goods and Services Tax (GST) almost set to roll out by Q2, 2017-18, an inquiry into the ramifications, not in terms of the politics surrounding the change but in terms of changes in the political institutions and norms, is of utmost importance. Apart from a radical shift in the tax code, GST has the potential to alter the federal character of India. To completely grasp the disruption potential of The Constitution (101st Amendment) Act, 2016, it is important to first revisit the journey of federalism in India before analysing the provisions of the said legislation.

The genesis of federalism in India lies in the Simon Commission Report, 1930 which advocated for the concept of Federalism for the first time in formal channels. Thereafter, following the Round Table Conferences and deliberations with stakeholders, the formalisation of the federal structure occurred with the Government of India Act, 1935 wherein the powers of the federal government, governor’s provinces and chief commissioners’ provinces were separated. However, the emerged federal arrangement was just in name and not in spirit, since the governor was ultimately only unanswerable to the viceroy and not the legislature. Furthermore, the act also ensured that the Governor had executive outreach to cripple any legislative move.

Upon Independence, when the constituent assembly had the power to shape India’s future and its federal character, one would expect a radical shift from the existing then position. However, the intermittent developments especially the fear of partition and subsequent partition of India and the then West and East Pakistan, the reluctance of few princely states to join independent India and major linguistic and ethnic clashes resulted in minor improvements in the Indian federal character. The present day understanding of the structure of the political and economic federation in India originates subsequent to The Constitution (7th Amendment) Act,1956. Though certain states were elevated in status, thus granting them certain extra political and executive powers the Parliament and the Union executive could still override the states’ decisions (under Articles 352, 356 and 360).

The polar character of the constitution where the centre had more power compared to the states is well noted in jurisprudence as well, especially highlighted in the cases of State of Rajasthan v Union of India, 1977, S.R. Bommai v Union of India,1994 and in the case of The State of West Bengal V. Union of India, 1963 where the court highlighted a few reason to not consider the Indian state as a typical federation since there is no provision of separate Constitutions for states. Secondly, the amendment of the Constitution can be done only by the Parliament and the states have no power to amend it by themselves. A state can be stripped off its legislative powers without its consent, unlike the US Constitution where every state must ratify any constitutional amendment. Finally, the distribution of powers is such that it allows for local governance by the states, while national policies to be crafted by the Centre.

The degree of handicap that the states face in terms of political federalism is undoubtedly higher than that in the case of economic (also called financial or fiscal) federalism. Since, the finances of the union and the states are derived predominantly from taxes and given such matters are enumerated in the Seventh Schedule of the Constitution of India, which is somewhat protected from any unilateral action by the centre by Article 368(2) which mandates the assent of half of state’s legislature for any alteration to the Seventh Schedule.

The initial view held was that the state doesn’t have taxing powers over goods that are interstate in character further substantiated by Atiabari Tea Co., Ltd. v State of Assam and Ors.,1961 where the court held that a state cannot exercise its power of taxation over interstate goods. The aforementioned judgment was however overturned within a year with Automobile Transport Rajasthan Ltd., Etc. v State of Rajasthan and Ors., 1962 the court shifted the balance of power, in terms of taxation to the state and from the center even if goods were interstate in character.

The idea of a pan-national Goods and Services Tax (GST) became a dominant discourse in Public Finance circles of India upon publication of the report of the Task Force on Goods and Services Tax under the Thirteenth Finance Commission, 2009 which claimed that the GST will bring about a form of federalism with the balance of power shifting away from the centre since the state will end up having a wider gamut of goods and services to tax. This claim has seen excessive criticism from various quarters claiming that it attempts to further distort the balance of power in favor of the center. The claim rests upon a reading of Clause 7 and 9 of Section 12 of The Constitution (101st Amendment) Act, 2016. The clauses stipulate that for a decision to be passed there should be 75 percent of the votes in favor of it and the center shall control 33.3 percent of the votes.

It is thus impossible for the States in the GST council to pass any proposed changes to the GST structure without the center’s approval. While the understanding is indeed true, one must read the Section 12 (4) of the Act alongside which reads “The Goods and Services Tax Council shall make recommendations to the Union and the States on”. Thus, the fact of the matter is GST Council is not empowered to make any rules and thus can’t violate the constitutional framework all by itself, even though the center practically enjoys a veto as per Section 12(9) of the Act.

The lack of a clear definition of the nature of federalism in India becomes more pronounced once the political federal structure is compared with the economic federal structure. The claim that GST constitutes a gross violation of federalism, a basic feature of the constitution, seems unsubstantiated. Thus, the 101st Amendment can be said to act as an instrument harmonizing the diverging notions of federalism and not necessarily diluting federalism completely. The impact of GST indeed goes beyond the political institutions of the country, however, it is important to focus on these institutions because the fragility of mainstream economic wisdom is transient at best, while these the political institutions are supposed to be resilient.

2 thoughts on “The Changing Face of Economic Federalism”

An insightful analysis of the political and economic federalism in India.

However, the author should have mentioned that he GST council will comprise of 32 members (29 State finance ministers, 2 UT finance ministers and the Union finance minister) which makes the quorum states-centric.

That should justify the Centre’s weightage of 1/3rd of the total votes cast in decision-making.

However, the decision will be done only after 3/4th majority have passed it meaning centre has a veto on decision making. Moreover GST council has made the parliament and state legislature redundant. They just have to pass the recommendations of gst council in form of bill and no power to deviate from recommendations.